The FTC's Sale of Business Exception
On January 8, 2023, the Federal Trade Commission (“FTC”) published a proposed rule that would effectively prohibit employers from enforcing non-compete clauses against their employees. Although this proposed rule is primarily targeted at employment-based non-competes (i.e., arising solely from an employment relationship), it also poses significant consequences for non-competes in the M&A context (i.e., arising from a sale of a business).
The Proposed Rule
Non-competes and similar restrictive covenants are ubiquitous in the M&A landscape, and are generally employed by buyers to prevent sellers from using their special knowledge and experience in an industry to re-enter the market and compete. While the proposed rule would categorically ban all employment-based non-competes, it aims to except non-competes between buyers and sellers in certain sale-of-business transactions. Specifically, the exception would only apply to non-compete agreements restricting the “substantial owners” of a target company. The proposed rule defines “substantial owner” to include any owner, member, or partner holding at least a 25% ownership interest in a business.
If approved, the practical effect of the proposed rule is relatively straightforward: unenforceability of sale-of-business non-competes with many minority owners. However, not all sub-25% owners are treated equally—in order for the non-compete to be considered unenforceable, the seller must be deemed a “worker” under the proposed rule. To the extent a minority owner’s role is uninvolved in the operations of the business, such as that of a passive investor, it is more likely a non-compete provision would be upheld, even if such owner held less than 25% of the total equity interests in the business. As currently contemplated, the definition of “worker” is broad, and includes any person who works, whether paid or unpaid, for an employer.
The FTC solicited public comment on the proposed rule earlier this year, which yielded nearly 25,000 submissions and proved to be one of the most debated topics in FTC history. The FTC is currently analyzing the comments and anticipates it will vote to finalize the proposed rule in April 2024. If approved, the proposed rule would take effect 180 days later, subject to anticipated litigation challenging the rule’s legality.
Effects on the M&A Market
The proposed rule could result in increased hesitation in M&A buyers as it hinders their ability to protect the goodwill of the business being purchased and provides a heightened threat of competition from minority sellers. On the other hand, such sellers will undoubtedly find increased flexibility in their post-transaction endeavors, whether or not the endeavor is directly competitive with that of the business. As a whole, it is unclear what effect, if any, the proposed rule will have on the M&A market at large and different parties’ propensity to strike deals.
*Special thanks to summer associate Lukas Schnepel for his contributions to this article.